June 28th, 2011

Lawmakers look at changing the inflation index as a way to trim the deficit

As the negotiations on a debt reduction package drag on, both parties have demanded that the certain items—tax hikes, Medicare, and Social Security cuts—be taken off the table. The standoff has forced lawmakers to become increasingly creative as they look for ways to trim trillions of dollars off the federal deficit. Aside from increased federal user fees and military spending cuts, Washington has also started buzzing about subtle but important possible changes to the cost-of-living indexes used to calculate retirement benefits and taxes.

Adjusting the consumer price index, which the Bureau of Labor Statistics uses to determine how much the cost of living goes up each year, could save hundreds of billions of dollars for the federal government. It is reportedly among the ideas being discussed during the closed-door debt ceiling negotiations, and the interest groups with the most to lose from it have already started to gear up their opposition. Changing the CPI would affect Social Security benefits and retirement payments for federal employees, as well as income taxes, but could be billed by lawmakers as a technical adjustment, not a tax hike or benefit cut. But make no mistake—a change in the CPI could affect millions of everyday Americans significantly in the pocketbook.

The CPI measures how much the costs of goods goes up each year due to inflation. But economists note that as prices change, families will change what they buy. If the price of beef goes up but poultry stays steady, for example, a chicken dinner might replace steak night, and ultimately a family might be able to keep its overall food costs from rising too much. The chained CPI, which the Bureau of Labor Statistics has calculated over the last decade as an alternative to the classic CPI, tries to take those substitutions into account, and ultimately produces a lower cost-of-living adjustment.

By switching to a chained CPI, the federal government could save more than $200 billion over the next decade, according to the Congressional Budget Office. Part of those savings would come from trimming Social Security benefits and retirement benefits for federal employees. Others would come from a slight increase in taxes—as the income brackets rise more slowly, more people would be kicked into higher brackets. Compared with more drastic deficit trims, a chained CPI seems politically feasible. It includes a small mix of benefit cuts and income tax hikes, pleasing both sides of the debate, and the changes would be slow and subtle. “This is something that’s gaining momentum in Washington,” says Marc Goldwein, policy director for the Center for a Responsible Fiscal Budget, which supports the idea. “It has a deep fiscal impact at a time when we’re desperately seeking deficit-reduction dollars. I think it’s absolutely on the table.”

That doesn’t mean it wouldn’t spark controversy. Although the cuts wouldn’t be much at first, as time goes on they would grow, to as much as 5 percent for older retirees two decades from now. As poorer retirees are less likely to be able to adjust their living habits, they could be affected most by such changes. The president’s fiscal commission recommended using the chained CPI for Social Security benefits, but also included increased payments to older and poorer workers to help with the effects. The senior advocacy group AARP has denounced the proposal, at least as part of a debt ceiling deal. “Any discussion around proposals that would impact Social Security must only happen in the context of strengthening retirement security, not balancing the budget,” said Barry Rand, CEO of AARP. The long-term effect of the income tax adjustments could be even greater than the adjustments for Social Security. Eventually, the adjustments would mean that millions of Americans might find themselves in higher tax brackets, which could affect their career earnings.

So far, Democrats and Republicans have avoided adding Social Security—the so-called lethal “third rail” of politics—into the debt ceiling discussions. Democrats have said that Social Security cuts should be off the table, and Republicans have shied away from proposing significant reforms to the 76-year-old program. Republicans have also insisted that tax hikes of any kind will not pass the Republican-controlled House of Representatives. But advocates of the chained CPI hope that this will be an opportunity for lawmakers to make baby steps toward compromise. “It does kind of skim the top of all these third rails,” Goldwein says. “In some ways, that’s more of a reason to do it. Some of the politicians want to prove themselves that they can do this.”